Golden era of market's second quarter proves risk of betting against stocks

By CHET CURRIER, BLOOMBERG NEWS

Published 10:00 pm, Friday, June 27, 2003

The breakout rally in stocks in the past three months corroborates what might be called the 80-20 rule.

This dictum states that 80 percent of the payoff from owning stocks or stock mutual funds comes in 20 percent of the time. Important corollary: You never know beforehand in which 20 percent the gains will occur.

Now that the second quarter of 2003 is almost over, it has stamped itself as one of those golden periods -- improbable as such a prospect might have seemed three months ago. As of the end of last week, 28 of the 30 categories of stock funds tracked by the research firm Morningstar Inc. showed three-month gains of at least 10 percent.

The lone loser was bear-market funds, which aim to profit from market declines. They were down 15.5 percent since late March.

At the head of the pack, sector funds specializing in technology and communications stocks sported gains of 20 percent or more. Likewise various categories of international funds and domestic funds focused on small stocks.

The smallest gainers were conservative allocation funds, up 7.7 percent.

Annualize these returns, and you get payoffs starting at about 45 percent and ranging well up into triple digits. Heady stuff by any standard.

But it's not as unusual as it might seem. From March 20 through June 20, according to my Bloomberg, the Standard & Poor's 500 Index posted a total return of 14.2 percent and the Nasdaq Composite Index gained 17.4 percent.

In the past 30 years, I found 14 other quarters in which the S&P 500 gained 10 percent or more, and 33 quarters during which the more volatile Nasdaq composite rose at least 10 percent.

Together, those account for 19.6 percent of the three-month calendar periods in the past three decades. Sure enough, as we posited at the outset, the big gains occurred in 20 percent of the available time.

Proponents of buy-and-hold stock investing always cite studies to this effect as evidence of how hazardous it is to try to time the markets.

They have a point.

If you sit out a period like the current quarter waiting for the economic skies to clear, you hobble your chances of success.

Given that the S&P 500's return over the past 30 years averaged 10.7 percent a year, each double-digit quarter that you miss costs you at least a year's worth of gains.

A check of the record shows you can't even use two-digit quarters as timing tools after the fact.

If you had pulled your money out of stocks after each of the last five quarters of 10 percent or better gains for the S&P 500, figuring that stocks were due for a reaction in the other direction, you would have missed an average gain of 3.3 percent in the ensuing quarters.

That's the annual equivalent of a 13.9 percent return, well above the presumed norm of 9 percent to 10 percent -- and not easy to equal or beat anywhere else in conventional investing.